3. Macro Economics

7/28/2019 3. Macro Economics

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Macroeconomics

The field of economics that studies thebehavior of the aggregate economy throughconsidering economy

wide elements:

changes in (un)employment

national income

rate of growth

gross domestic product

inflation and price levels

Objectives Full employment

Real economic growth growth in national income per head of population

improved living standards

an acceptable distribution of wealth

Price stability Limited inflation

An acceptable balance between exports and imports Manageable balance of payments over time.

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The Circular Flow

The main stream

flows clockwise

around the circle,

first as income

from firms to

households the

lower half of the

circle then as

spending from

households to

firms

the upperhalf of the circle.

For each flow of

money there is

an equal and

opposite flow of

goods or

resources.


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Gross Domestic Product

Considered as:

The total market value of all final goods and servicesproduced within the country in a given period of time(usually a calendar year).

The sum of value added at every stage of production (theintermediate stages) of all final goods and servicesproduced within a country in a given period of time.

The total output of goods and services during a year,measured at purchase price.

Consumption + Investment + Government Spending

+/- Balance of payments.

Consumption

Private (household) consumption influenced

by:

the level of households incomes,

the rate of tax, and

the portion of a households income that is

saved.

Investment

Made by organizations and households in

capital items:

Buildings

Construction works

Plant and equipment

New houses (household capital expenditure).

Government spending

Covers all government consumption (on final

goods and services) and government

investment (e.g. infrastructure).

In most economies, government spending

forms a large portion of the countrys GDP

and will be determined by the governmentsfiscal policy.


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Balance of payments

The value of exports minus the value of imports.

GDP measures what is produced domestically,

thus:

exports are included (as these would not be

recorded under household or government

expenditure)

imports are deducted (as they would not have been

produced domestically, yet will be included within

household and government expenditure as

consumption).

GDP: Expenditure Approach Using the expenditure approach, an economys

aggregate expenditure equals the sum of

Consumption, C

Investment, I

Government Purchases, G

Net Exports, (Exports, X, minus Imports, I)

C + I + G + (X M) = Aggregate Expenditures = GDP

Inflationary and deflationary gap

In a situation where resources are alreadyfully employed, there may be an inflationarygap since increases in demand will cause pricechanges, but no variations in real output. A

shift in demand or supply will not only changethe national income, it will also change price

levels. A deflationary gap exists when there is

insufficient demand available in the economyto generate a full-employment equilibrium. Inother words there is not enough being boughtto provide jobs for everyone who wants them.

Factors that influence level of

business activities

Consumer confidence

Aggregate demand

Capital (availability of finance)

Exchange rates

Use of resources (new tech, adv in educationetc)

Government policy


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Business trade cycle Recession

A general definition of being in a recession is

when GDP is negative for two or more

consecutive quarters.

As demand falls and businesses reduce their

output, individuals may lose their jobs and as a

result, there is increased pressure on household

incomes and demand falls yet further.

Returns on investment will decline with some

projects being cut or put on hold. Orders will

decline, inventory levels reduce, prices will fall

and some business will face closure.

Depression

Depression is a severe economic downturn that

will usually last several years. Annual GDP decline

will be of the order of -5% to -15%.

The main driving factor is a loss of consumer

confidence. Consumers do not buy, but try to

survive on basic goods and services and savewhat they can.

Some characteristics of a depression are mass

unemployment, restriction of sources of finance,

reduced output and currency volatility.

Recovery

As and when consumer confidence returns

businesses will begin to retool, restock and

employ more people.

As recovery continues, the output level will

rise above the general trend line, entering into

the boom phase.


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Boom

Households will have higher incomes due tohigher salaries, higher share of profits and

higher dividends.

Capacity and labor become fully utilized. Thiswill lead to increasing costs as competition forlimited resources intensifies or the demand ismet through importing. Increasing the salesprice may also be a result of trying to controldemand.

I nfl ation

Inflationis a sustained increase in theaverage price level

Hyperinflation: Extremely highinflation, German hyperinflation of1922/23

A sustained decrease in the averageprice level is called deflation

A reduction in the rate of inflation iscalled disinflation

The rate of increase of the general level of

prices being a sustained increase in the

aggregate or general price level in an

economy.

Various measures include CPI, RPI, PPI, IPI,

OPI

A CPI attempts to measure changes over time

in the monetary cost of a statistically

weighted representative basket of goods

and services.

Causes of Inflation

Demand-pull inflation isinflation initiated by anincrease in aggregatedemand.

Cost-push, orsupply-s ide,inf lat ionis inflation caused by anincrease in costs.


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Costs of inflation

Consequences of high inflation include:

Lower standards of living

Redistribution of income: Fixed income,borrowers vs. lenders

Disincentive to save : e.g. Buy today, or it will beexpensive tomorrow

Impact on money, imports and exports

Causes uncertainty and stifles businessinvestments

Wage-price spiral

Shoe Leather costs. If inflation forces up the

price of raw materials or components, the

firm will be forced to shop around for cheaper

raw materials or components, again increasing

costs to management.

Increasing menu costs. If inflation is at a high

level, firms will have to continuously re-price

goods. This re-pricing brings with it costs such

as reprinting of brochures, sales details etc.

Unemployment

The amount of joblessness in the economy. A person is generally unemployed if they are willing and

able to work, but cannot find employment.

Categories include: Real wage: caused by wages in the labor market being

pushed beyond the equilibrium as a result of trade unionaction or minimum wage requirements, resulting inbusinesses being able to afford to employ fewer staff.

Frictional: caused by workers moving between jobs

Seasonal: caused because of seasonal fluctuations indemand for labor

Structural: : caused by structural change in the economy,leading often to a change in skills required.

Cyclical: caused by the fall in aggregate demand.

Hidden

Unemployment

Consequences include:

Adverse social effects social blight

Greater divisions within society

Higher governmental costs

Loss of potential for maintaining or increasingnational output and income

Loss of work skills and experience

Government policies include:

Job creation schemes, grant assistance, incentives

Labour mobility schemes


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Stagnation

A relatively long period of very low or no

economic growth

Economic growth of less than 2% - 3%

Slow or sluggish growth = existing

unemployment levels cannot be lowered

Weak demand for goods and services

Stagflation

A combination of high unemployment and

high inflation

Reduced job opportunities, lower pay

packages and rising prices

Reduced demand for goods and services and

increased in prices of raw materials.

International Payments

Disequilibrium

Occurs when the balance of payments isnegative.

The balance of payments:

Is a record of a countrys transactions with the rest ofthe world

Shows the net receipts from various aspects of trade

and consists of the current and financial account. A separate capital account shows the impact of the

capital elements contained within the current andfinancial accounts.

Current account

The record of payments in trade and services,

sub divided as:

balance of payments (trade) in goods - visibles

balance of payments (trade) in services, e.g.

tourism, insurance - invisibles

net income flows (e.g. wages and investmentincome)

net current transfers (e.g. government aid).


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Financial account

A measure of the net payments to and from

other countries for investment purposes, e.g.

investment abroad (outward investment)

investment from abroad (inward investment)

Monetary policies

Those actions taken by the government or

the central bank to achieve economic

objectives using monetary instruments.

These actions may either directly control the

amount of money in circulation (the money

supply) or attempt to reduce the demand for

money through its price (interest rates)

Money supply

Can be controlled through:

Interest rates

Credit controls

Direct intervention by central bank

Foreign exchange

Open market operations

The impact on a business of higher interest rates

People may borrow less because

it costs more money to pay back

the loan

So people buy fewer

consumer goods

So businesses sell

fewer products

It costs the business more

money to pay back any loans

So the business needs to

find more money to pay

back its loans

The business decides not

to invest in new

equipment

The business may make less profit

The business becomes less competitive


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The impact on a business of lower interest rates

People may borrow more

because it costs less money to

pay back the loan

So people buy more

consumer goods

So businesses sell

more products

It costs the business less money

to pay back any loans

So the business needs

to find less money to

pay back its loans

The business decides to

invest in new equipment

The business may make more profit

The business becomes more competitive

Exchange rate

The exchange rate is the price of one currency

expressed in terms of another.

If the UK exchange rate increases it means the

pound sterling is stronger and other

currencies are weaker

Appreciation

Depreciation

Fiscal policy

Action by the government to achieve economicobjectives through the use of the fiscalinstruments of taxation, public spending and thebudget deficit or surplus.

Reflate an economy through:

Increased government spending

Reduced taxation

Deflate an economy through:

Reducing government expenditure

Increasing taxation


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Borrowing:

To the extent that a government's expenditure

exceeds its income it must borrow to make up

the difference.

The amount that the government must

borrow each year is now known as the Public

Sector Net Cash Requirement (PSNCR) or in

UK it is was formerly named as Public Sector

Borrowing Requirement (PSBR).

Fiscal policy

Reflating problems:

Intervention into a free market

Unemployment

Time lags

Tax cuts may not boost domestic demand

Budget deficit plus increased inflation

Deflating problems:

Government spending cannot be drastically cut

Time lags

Increased taxes discourages enterprise

Supply side approach

Policies that focus on creating the right

conditions in which private enterprise canflourish

Raise the capacity of the economy to providethe output demanded.

The private sector, being driven by the profitmotive, is deemed to be more efficient atproviding the output required than the publicsector

Supply side approach

Supply side policies include:

low tax rates to encourage private enterprise

the promotion of a stable low inflation economy

limited government spending and intervention

a balanced fiscal budget

deregulation of industries

reduction in the rights of employees/power of tradeunions

increase in the training and education of the workforce

increase of business infrastructures

a reduction in planning legislation


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Taxation

Used to:

raise revenues for the government (fiscal policy)

raise barriers to activities considered undesirable

price products at their social costs

redistribute income and wealth

protect industries from foreign competition and

dumping

Taxation forms

Proportional taxation Based on a fixed proportion of the item base

Progressive taxation Increases as the tax base increases

Direct taxes Paid directly to the government can be

proportional or progressive and are usuallyunavoidable

Indirect taxes Not paid directly by the end user, but are collected

by the government through an intermediary

Economic growth

Measured by increase in the real GNP per

head of the population

Actual economic growth is the annual

percentage increase in national output, which

typically fluctuates with the trade cycle

Potential economic growth is the rate at which

the economy would have grow if all resources

were fully utilized

Consequences of economic growth

+ increase in income per head

+ higher level of consumption

+ better living standard

+ better social services without increasing taxes

- Depletion of natural resources- Create pollution

- Structural unemployment


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Privatization

For:

an increase in competition

a short-term boost to government revenues

a widening of share ownership

Against:

public sector monopolies become private sector ones

loss of economies of scale if broken up

deteriorating quality of service

profit is the motive and not social welfare

Barriers to international trade

Tariffs

Quotas

Embargos

Documents

3. Macro Economics